Consumer retrenchment in goods spending, inflation mild

Summary

Inflation rose at only a mild pace in January and income rose more than twice the expected amount. But inflation-adjusted spending dropped half a percentage point, the biggest monthly retrenchment in almost four years. A pullback in autos and other goods was mostly to blame.

Sharp pullback in goods spending

January's personal income and spending report was full of surprises. Income came in hot growing 0.9% which was more than double the expected gain of 0.4%. Spending fell on both a real and nominal basis. The decline is the first in 22 months though it does come on the heels of upward revisions to December data.

We have been cautioning about some potential pull-forward in goods spending as consumers try to squeeze in big-ticket purchases before tariffs go into effect. At some point we feared there would be payback. January is sooner than we would have expected to see it. Yet, how else to explain the fact that among the categories posting a decline in January seven out of the top eight decliners were goods categories.

The bottom dropped out beneath motor vehicles & parts spending with a $41.1 billion dollar decline. For most households, this is the definition of a major outlay and the category had seen decent strength rising 3 out of the past 5 months. Recreational goods and RVs made up the second largest decliner in January spending followed by other non-durable goods. Other goods categories in the red included clothing & footwear as well as food & beverages. In fact, the only goods category to post a gain was gasoline and other energy goods, a mostly price-related development.

The pop in overall income is partially attributable to one-off factors that typically impact the start of the year. The first is the annual cost of living adjustment (COLA) to social security, which drove this portion of income up 2.8% in January, and accounted for two-tenths of the overall gain in income. Strength can also be traced to receipts on assets and proprietors income.

Yet all of the strength can't be talked away. Wages & salaries, which comprises a bulk of households income and thereby spending power were also up a strong 0.4%, adding to a string of solid gains the past three months consistent with a sturdy labor market. All told, in adjusting for inflation and taxes, real disposable personal income rose 0.6% in January, or at the fastest pace in a year.

Inflation is still a challenge not just for the Fed but for consumers looking to spend on discretionary items. Earlier this month we learned the CPI surprised to the upside and this morning's data show the Fed's preferred measure of inflation, the PCE deflator, rose 0.3%, which was enough to drive the year-over-year rate lower to 2.5%. Goods inflation (+0.5%) outpaced services inflation (+0.2%) for the first time in at least six months. The core measure (excluding food and energy) was up a similar amount in January, which drove the annual rate down to 2.6% from an upwardly revised 2.9% in December. On a three-month average annualized basis, core inflation sits at 2.4% today.

While risks today look skewed to the upside around inflation, the pricing environment remains highly uncertain. Consumers are price fatigued, and major retailers have acknowledged this. Tariffs are the most obvious threat to the pricing environment and the last few tenths to the Fed's 2% target remain in the crosshair.

Consumer spending has been a stalwart driver of economic growth throughout the current expansion. Yesterday's Q4 GDP revisions lifted the annualized rate of consumer spending to a blistering 4.2%, the second fastest quarterly expansion in consumer spending in the past three years. Today's report does not fundamentally alter our thinking on the sustainability of consumer spending though it does offer a look at what consumer life might look like in a world where goods spending is put on ice.

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